M1: The Firm and Market Structures

What is Total Revenue (TR)?

TR = P × Q. It is the total amount received from selling output.

What is Total Cost (TC)?

TC = TFC + TVC, where TFC is total fixed cost and TVC is total variable cost.

What is Average Total Cost (ATC)?

ATC = TC / Q. It is the firm's total economic cost per unit of output.

What is Average Variable Cost (AVC)?

AVC = TVC / Q. It is the firm's variable cost per unit of output.

What is Marginal Cost (MC)?

MC = ΔTC / ΔQ. It is the additional cost of producing one more unit.

What is Marginal Revenue (MR)?

MR = ΔTR / ΔQ. It is the additional revenue generated by selling one more unit.

What does "marginal" mean?

Think "one more." MR = revenue from one more unit; MC = cost of one more unit.

What is the general profit-maximizing output rule?

Produce where MR = MC, with MC rising.

Why produce more when MR > MC?

The additional revenue exceeds the additional cost, so another unit increases profit.

What if MR < MC?

The additional unit costs more than it generates in revenue, so output is too high.

Why must MC be rising at the profit-maximizing MR = MC intersection?

MR = MC alone is not sufficient. An intersection where MC is falling may not represent maximum profit.

What is economic profit?

Economic Profit = Total Revenue − Total Economic Costs. Economic costs include explicit costs and opportunity costs.

What does zero economic profit mean?

The firm earns normal profit: enough to cover all economic costs, including opportunity costs. It does NOT mean the owners earn nothing.

What is the breakeven condition?

TR = TC, equivalently P = ATC. Economic profit equals zero.

What does P > ATC indicate?

Positive economic profit.

What does P = ATC indicate?

Breakeven: zero economic profit or normal profit.

What does P < ATC indicate?

An economic loss.

What is the short-run shutdown rule?

Operate if P ≥ AVC. Shut down if P < AVC.

Why might a loss-making firm continue operating?

If AVC ≤ P < ATC, revenue covers variable costs and contributes toward fixed costs. Therefore the firm should continue operating in the short run.

What is the shutdown point?

The minimum point of the AVC curve: P = minimum AVC.

What is the key ATC vs AVC exam shortcut?

ATC = "Am I profitable?" AVC = "Should I keep the lights on?"

If TR ≥ TC, what should the firm do?

Operate in both the short run and long run.

If TVC ≤ TR < TC, what should the firm do?

Operate in the short run but exit in the long run if the situation persists.

If TR < TVC, what should the firm do?

Shut down in the short run and exit in the long run if conditions persist.

Why are fixed costs ignored in the short-run shutdown decision?

They are unavoidable in the short run whether the firm produces or shuts down.

What changes in the long run?

All inputs are variable. A firm consistently earning negative economic profit will exit.

What is LRAC?

Long-Run Average Cost: the lowest average cost achievable at each output when the firm can adjust all inputs, including plant size.

What are economies of scale?

LRAC falls as output increases. Bigger production scale leads to lower average cost.

What can cause economies of scale?

Specialization, efficient equipment, volume discounts, better utilization, and spreading costs over greater output.

What are diseconomies of scale?

LRAC rises as output increases because the firm has become too large or complex.

What can cause diseconomies of scale?

Coordination problems, bureaucracy, management difficulties, duplication, and input-price pressures.

What are constant returns to scale?

Output increases proportionately with inputs and long-run average cost remains unchanged over the relevant range.

What is Minimum Efficient Scale (MES)?

The smallest output level at which the firm reaches its minimum LRAC.

Exam Tip: What should a firm below MES generally do?

GROW. It should increase scale to exploit economies of scale and move toward minimum LRAC.

Exam Tip: What should a firm in the diseconomies-of-scale region do?

DOWNSIZE. It has become too large and should move back toward its efficient scale.

What five characteristics distinguish market structures?

Number and relative size of firms; product differentiation; pricing power; barriers to entry/exit; and non-price competition.

What characterizes perfect competition?

Many sellers, homogeneous products, very low entry barriers, no individual pricing power, and essentially no non-price competition.

What characterizes monopolistic competition?

Many sellers, differentiated products, low entry barriers, some pricing power, and substantial branding/product differentiation.

What characterizes oligopoly?

Few major firms, high barriers to entry, homogeneous or differentiated products, and strategic interdependence.

What characterizes pure monopoly?

One seller, no close substitutes, very high barriers to entry, and considerable pricing power.

What is the easiest market-structure memory rule?

Perfect = many + same. Monopolistic = many + different. Oligopoly = few + strategic. Monopoly = one + protected.

What demand curve does an individual perfectly competitive firm face?

A horizontal, perfectly elastic demand curve at the market price.

What does perfectly elastic demand mean for a competitive firm?

The firm can sell at the market price but cannot charge more because buyers can purchase an identical product elsewhere.

Is the entire market demand curve perfectly elastic under perfect competition?

No. The individual firm's demand is perfectly elastic; overall market demand is normally downward sloping.

What is the revenue relationship under perfect competition?

P = MR = AR.

Why does P = MR under perfect competition?

The firm can sell another unit at the same market price without lowering the price on previous units.

What is the profit-maximizing condition under perfect competition?

Because P = MR and profit maximization requires MR = MC, the firm produces where P = MR = MC.

What happens when perfectly competitive firms earn positive economic profit?

New firms enter → market supply increases → price falls → economic profit decreases.

What happens when perfectly competitive firms suffer economic losses?

Firms exit → market supply decreases → price rises → losses of remaining firms decrease.

What is long-run equilibrium?

A situation where firms have no incentive to enter or exit the market.

What is long-run equilibrium under perfect competition?

P = MR = MC = minimum ATC, and economic profit equals zero.

Does zero long-run economic profit under perfect competition mean firms earn nothing?

No. Firms earn normal profit, covering all economic costs including opportunity costs.

What demand curve does a monopolistically competitive firm face?

A downward-sloping demand curve because its product is differentiated.

Why does product differentiation create pricing power?

Consumers do not view competitors' products as perfect substitutes, allowing the firm some ability to set price.

What is the relationship between P and MR under monopolistic competition?

P > MR.

Why is MR below P under monopolistic competition?

To sell an additional unit, the firm generally lowers price. The lower price also applies to units it was already selling, so the additional revenue is less than the selling price.

What is the key MR memory trick?

To sell MORE, I lower the price — and I lower it on ALL. Therefore MR < P under downward-sloping demand.

How does a monopolistically competitive firm choose quantity?

Find the quantity where MR = MC.

How does a monopolistically competitive firm choose price?

After finding Q* from MR = MC, move up to the demand curve at that quantity to determine P*.

What is the key graph exam rule for imperfect competition?

MR = MC finds Q. Demand curve finds P.

Can a monopolistically competitive firm earn positive economic profit in the short run?

Yes. If P > ATC at the profit-maximizing quantity, economic profit is positive.

What happens to positive economic profit under monopolistic competition in the long run?

Low entry barriers attract competitors → each incumbent's demand decreases → economic profit is driven to zero.

What conditions hold in long-run monopolistic competition?

MR = MC; P = ATC; economic profit = 0; and P > MR.

Does a monopolistically competitive firm operate at minimum ATC in long-run equilibrium?

No. It operates at an ATC above the minimum possible ATC.

What is "minimum average cost" referring to?

The lowest point on the ATC curve — the cheapest average total cost per unit the firm could achieve.

What is excess capacity under monopolistic competition?

The firm produces less than the quantity that would minimize ATC, so its actual ATC is higher than minimum ATC.

Exam Tip: What is the major long-run difference between perfect and monopolistic competition?

Both earn zero economic profit, but perfect competition operates at minimum ATC while monopolistic competition does NOT.

What is non-price competition?

Competing through advertising, branding, packaging, quality, style, or product differentiation rather than only through price.

Why is non-price competition important under monopolistic competition?

Product differentiation is the source of the firm's pricing power.

What is the defining feature of oligopoly?

Strategic interdependence: each firm must anticipate competitors' reactions to its decisions.

Why is there no single oligopoly model?

Different oligopolies exhibit different strategic behavior, so multiple models describe possible pricing and output outcomes.

What does the kinked demand curve model explain?

Price rigidity or price stickiness in oligopoly.

What does a firm expect if it raises price in the kinked-demand model?

Competitors do NOT follow, causing the firm to lose substantial sales. Demand above the kink is relatively elastic.

What does a firm expect if it cuts price in the kinked-demand model?

Competitors match the cut, so the firm gains relatively little market share. Demand below the kink is relatively inelastic.

Why can price remain unchanged when MC changes under the kinked-demand model?

MR has a discontinuity. MC can shift within the MR gap without changing the profit-maximizing output or price.

Exam Tip: What is the major kinked-demand curve trap?

The model explains why an existing price is sticky, but does NOT explain how the original prevailing price was determined.

What is Cournot competition?

Firms simultaneously choose quantities, taking competitors' quantities as given.

What is a Cournot best-response function?

The firm's profit-maximizing output given the output chosen by its competitor(s).

What is Cournot equilibrium?

The intersection of firms' best-response functions, where each firm's chosen quantity is optimal given competitors' quantities.

What happens to the Cournot outcome as the number of firms increases?

It approaches the perfectly competitive outcome: generally higher total output and lower prices.

Exam Tip: What is the Cournot shortcut?

Cournot = QUANTITY competition.

What is Nash equilibrium?

A set of strategies where no player can improve their outcome by unilaterally changing strategy, given everyone else's strategies.

Does Nash equilibrium mean everyone achieves the best collective outcome?

No. It only means each player's strategy is individually optimal given the strategies of others.

How are Cournot and Nash related?

Cournot equilibrium is a Nash equilibrium in quantities. Nash is the broader concept.

Exam Tip: What word should trigger Nash equilibrium?

UNILATERAL. No player benefits from changing strategy unilaterally given the strategies of others.

What is the dominant firm model?

One large firm effectively determines price based on residual demand, while smaller fringe firms accept that price and produce where their MC equals price.

What is the dominant-firm memory rule?

Big firm leads; small firms follow.

What is collusion?

Firms cooperate explicitly or tacitly to restrict output and raise prices toward the monopoly outcome.

What is the basic economic effect of successful collusion?

Restrict output → higher price → higher joint profits.

What conditions make collusion easier to sustain?

Few firms, similar products, similar cost structures, stable demand, easy detection of cheating, and credible punishment.

Why is collusion unstable?

Individual firms may have an incentive to cheat by secretly increasing output or cutting price while competitors cooperate.

Can oligopoly firms earn positive economic profit in the long run?

Yes. High barriers to entry can allow economic profits to persist.

How does a single-price monopoly choose output and price?

Choose Q* where MR = MC, then use the demand curve at Q* to determine P*.

What is the P–MR relationship for a monopoly?

P > MR because the monopolist faces downward-sloping market demand.

Can a monopoly earn positive economic profit in the long run?

Yes. High barriers to entry can prevent competitors from eliminating excess profits.

What is the N-firm concentration ratio?

The combined market share of the largest N firms: CRN = sum of market shares of the top N firms.

What are common concentration ratios?

CR4 and CR8, representing the combined shares of the largest four or eight firms.

What does a high concentration ratio generally indicate?

A relatively concentrated industry dominated by a small number of firms.

What is a major weakness of concentration ratios?

They do not show how market share is distributed within the top N firms.

Give an example of the distribution problem with CR4.

25%/25%/25%/25% and 70%/10%/10%/10% both have CR4 = 100%, despite very different competitive structures.